Discover Maintains Loan Growth To Beat Market Expectations
Discover Financial (NYSE:DFS) beat market estimates for the first quarter of 2014, with a 4% increase in revenues (net of interest expense) driven by a 6% growth in total loans. Credit card loans, which account for 80% of the company’s loan portfolio, grew 5%, leading to an 11% increase in net interest income. [1] Card sales volume for the quarter grew 3% over the prior year, driven mostly by high spending consumers. This led to a 5% year-on-year increase in discount revenue.
Discover also continued its foray into direct banking; student loans grew 5%, while personal loans increased 27% over the prior year.
Our $46 price estimate for Discover Financial implies a discount of 20% to the current market price.
- Up 8% YTD, What To Expect From Discover Financial Stock In Q1?
- Up 14% YTD, What’s Next For Discover Financial Stock?
- Discover Financial Stock Is Undervalued
- Discover Financial Stock Is Fairly Priced At The Current Levels
- Discover Financial Stock To Edge Past The Revenue Consensus In Q1
- Discover Financial Stock Is Attractive At The Current Levels
See our complete analysis of Discover Financial here
Loan Growth Is Important
Unlike card giant Visa (NYSE:V), Discover issues credit cards directly to consumers, allowing customers to maintain revolving credit card balances on which the company earns interest. Interest income from credit cards accounts for 60% of the company’s revenue. As a result, Discover’s business model is not volume-driven but is more reliant on the loan balance that the company is able to maintain and the interest it can earn on this balance.
Discover accounts for nearly 6% of revolving consumer credit in the U.S. and observed loan growth despite market contraction through the first three months of the year. [2] The company has been able to maintain growth through lucrative card schemes such as its Discover IT and Discover More cards, which offer 5% cash back on various categories which change throughout the year. Management attributed a double digit increase in accounts through the quarter to the success of Discover IT, which was introduced last year.
Electronic payment penetration in the U.S. is quite high, with over 60% of personal consumption expenditures coming through non-cash transactions. [3] Therefore, growth in the country is more dependent on consumer sentiment than increased penetration. A recent report by the Bureau of Economic Analysis showed that both disposable personal income and personal consumption expenditures grew 0.3% through January and February. [4] This provides an indication of improving consumer sentiment. We expect Discover to gain further as the U.S. economy continues to improve.
For the first quarter, Discover’s credit card charge-off rate or the percentage of loans that are considered unredeemable, improved 4 basis points to 2.32% while delinquency rate for credit card loans over 30 days past due improved 5 basis points to 1.72%.
Discover did not sell off any of its charged-off accounts after the recession and thus benefited as the U.S. economy improved with strong recoveries on its inventory of charge-offs. However, in the coming years, the company does not expect the same level of recoveries and is making adjustments to its loans reserve.
As a percentage of average credit card loans, the provisions were around 2.76% in 2008 but increased to 6.63% in 2010. In 2011 and 2012, the company benefited from the aforementioned recoveries and its provisions as a percentage of average credit card loans fell to 1.54%. Provisions for loan losses increased 70% through the first quarter of 2014, following a 27% increase through 2013. We expect the provisions to reach pre-recession levels in the next three years.
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